Darden analysis: Why revenue is largely driven by new stores

Companies’ share prices heavily depend on their bottom line—EBITDA, earnings, or cash flow. If earnings are expected to rise or are rising, share prices will often rise. Conversely, if earnings are expected to fall, then share prices could fall—unless the market has already priced in these expectations. To get a quick sense of restaurant companies’ overall performance, the three basic accounts that investors should look at are revenue, which is dependent on same-store sales and number of stores, as well as margins.

Looking back at the last five years of data, Darden International Inc.’s (DRI) revenue has been growing. From 2009 to 2013, revenue at Darden has grown from just $7.2 billion in fiscal year 2009 to $8.5 billion recently, marking an average yearly growth of 4.3%. Of the four different segments, brands under the specialty group have reported the best performance, at 24.93%—far above LongHorn Steakhouse’s 8.49%, Olive Garden’s 2.84%, and Red Lobster’s 0.00%.

Higher revenue isn’t always positive

Generally, higher revenue is considered a positive for share prices. When revenue is rising, earnings often rise, which should support share value growth. Sometimes, though, not all revenue accompanies higher earnings. While operating margins gradually grew from 8.0% to 9.0% from 2009 to 2012, driven by higher pricing and more guests as the economy and spending grew, DRI’s operating margin fell by a larger step, from 9.0% in 2012 to 7.0% based on LTM (last twelve months) data.

Competition and an unfavorable price-to-value mix hurts margins

When margins (profitability) are pressured, they often reflect increased competition. Margins fall due to lower sales leverage (think of sales leverage as the amount of revenue the brand can bring in) or higher costs. Sales leverage depends on guest count and average check. This means if restaurant companies are selling at a price point that isn’t appealing to customers, guest count could be negatively affected. Conversely, if menu dishes are too cheap and guest turnover isn’t high, they can also negatively affect profitability.

Over the past five years, we’ve seen a steady decline in sales per store at Olive Garden and Red Lobster. This suggests Darden is making smaller new stores or that sales are falling. But one thing is clear: much of the revenue growth these two brands have seen was driven by store expansion rather than organic revenue growth at each restaurant.

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